Medicare - Summary of the 2012 Annual Report

Nothing is as boring as reading about Medicare benefits and costs.  However, nothing is as important either, because of the profound effect this will have on our future taxes.  The AIER has done a nice job of summarizing the 2012 Annual Report of the Medicare Trustees.  From AIER:

The article is in italics and portion in bold is my emphasis.

Don’t be fooled by overly optimistic projections. It’s even worse than you think.

The 2012 annual report of Medicare trustees presents a gloomy picture for those counting on Medicare assistance. Unless something changes, the Medicare trust fund will be depleted in the next 12 years.

This means that a 65-year-old who enrolls in Medicare today will lose services when he or she turns 77—an age below the average U.S. life expectancy, and one at which medical needs are usually high.

Troubling as it may seem, this projection is actually the best case scenario. It is based on optimistic assumptions that are unlikely to hold true.

Chart 1 below shows the annual report’s official projection of total Medicare costs as a percent of GDP. It reveals a rapid increase in Medicare costs relative to GDP over the next 25 years as baby boomers become eligible and enroll.

Official estimates assume that current laws and institutional arrangements will prevail for the projection period. But reality is likely to unfold differently, making official projections—and the government and household decisions based upon them—highly inaccurate.

To address these inaccuracies, the Office of the Chief Actuary of Medicare created an alternative trajectory of Medicare costs based on more realistic assumptions (see Chart 1).

The alternative projections show that unless substantial changes are made, Medicare costs will be significantly above official projections. This substantial increase in costs will necessitate changes in both Medicare benefits and taxes—an eventuality for which everyone should prepare.

Past projections of Medicare costs have been far off the mark. When Medicare was first introduced in 1965, the House Ways and Means Committee estimated that inflation-adjusted Medicare would cost about $12 billion by 1990. In reality, it cost about $110 billion. By 2010, the cost rose to around $523 billion.

The sheer magnitude of the difference raises the question of whether projections have any real value. This has serious implications for U.S. public debt. Unreliable projections also mean that individuals may have a hard time predicting their tax liability and the availability of government-sponsored health care assistance programs.

To understand the flawed assumptions in the official projections, it’s important to know that Medicare has two components. Hospital Insurance (Medicare Part A) pays for hospital stays, skilled nursing facilities, and hospice care for the aged and disabled. Supplementary Medical Insurance (Medicare Parts B and D) pays for physicians’ and other outpatient services and provides subsidized prescription drug insurance coverage.

Official projections assume that physicians’ reimbursements under Medicare Part B will be reduced by 31 percent starting in 2013. This reduction is currently called for under the Medicare Sustainable Growth Rate (SGR) formula first introduced in 1997.

The projections also assume that payments for most non-physician Medicare providers will decrease because of growth in economy-wide productivity, according to the provision of the 2010 Patient Protection and Affordable Care Act. The annual report’s estimates also depend on the proper functioning of the Independent Payment Advisory Board, also created by the Affordable Care Act, with a mandate to reduce the growth rate of Medicare costs.

It is unlikely that any of these assumptions will bear out in the future.

If health care costs grow at a faster rate than the economy does, the SGR formula is supposed to keep costs in check by cutting physicians’ payments. In every year since 2001, the formula has called for physicians’ reimbursement rates to be cut by 5 percent or more. But Congress has overridden this cut every year except 2002, fearing that doctors would stop accepting Medicare patients if their reimbursement rates decreased.

While Congress can reject recommended cuts, they do not go away. Instead, the law requires that postponed reductions be added to the reduction scheduled for the next year. Since reimbursement reductions have been delayed for a decade, the cumulative reduction scheduled for 2013 is very large—31 percent. It is unlikely that the Congress will allow Medicare payments to doctors to decrease by such a large amount. This makes projections that assume such a cut unrealistic.

The official projections also hinge on innovations in health care  delivery systems that are highly uncertain. The Affordable Care Act requires that annual payments for most Medicare services be moderated by the rate of increase in economy-wide productivity.

In practice, the efficiency of the delivery of health care services has never increased as fast as overall productivity. The productivity adjustment required by law would reduce the effective payments doctors and hospitals receive for treating Medicare patients.

This, in turn, could compromise Medicare beneficiaries’ access to medical care. For this reason, it is likely that the productivity adjustment will be legislatively amended or abandoned at some point. Actual Medicare costs will therefore be higher than the ones projected under the current law.

When Medicare spending per beneficiary exceeds specified thresholds, which is expected to happen often, the Advisory Board is charged with finding measures to reduce it. Since reductions in physicians’ payments and productivity adjustments are not likely to be implemented, the Board will have to find some other way to bring costs substantially down. But it is unclear whether the Board will be able to effectively design proposals to do this.

The more realistic alternative scenario created by the Office of the Chief Actuary assumes that Medicare physicians’ payments will grow at the rate of average U.S. health care spending. It assumes that Medicare providers might not keep their costs within the limits of reimbursement rates, leading Congress to increase rates. The alternative scenario additionally assumes that the Board will have limited ability to hold down Medicare cost growth rates.

Unsurprisingly, with these assumptions the future costs of Medicare come in much higher than the official projections suggest. As Chart 2 at right shows, under the alternative scenario costs for Medicare Part A will rise substantially above official projections beginning around 2027. Under official projections, Part A costs are expected to rise from 1.7 percent of GDP in 2011 to 2.7 percent of GDP in 2080. Under the alternative scenario, costs will rise to 4.1 percent of GDP in 2080.

No matter which projections we take, the trust fund for Medicare Part A will be exhausted in 2024. For Medicare to survive after that, costs will have to be covered by current tax revenue.

Under the official projections, we will need to collect an additional 1.4 percent of taxable payroll to keep Medicare Part A viable for the next 75 years. To cover the much higher costs projected under the alternative analysis, we will have to collect an additional 2.8 percent of taxable payroll in taxes.

In 2011, Medicare taxes amounted to 3.2 percent of taxable payroll. To cover future costs under the alternative scenario, taxes will have to be raised to 6.0 percent of taxable payroll—almost double their current level.

For Medicare Part B, the discrepancy between the official projections and more realistic alterative ones is even larger (see Chart 2). Under the current law, the cost of Medicare Part B is expected to rise from 1.5 percent of GDP in 2011 to 2.4 percent of GDP in 2040 and 2.5 percent in 2080. Under the more realistic scenario, costs of Medicare Part B will rise to 3.2 percent of GDP in 2040 and 4.4 percent in 2080.

Medicare Part B is covered by general tax revenue and by monthly premiums paid by enrollees. The premiums cover 25 percent of program costs. Taxpayers cover the remaining 75 percent.

If costs of Medicare Part B grow as the alternative scenario suggests, they will more than double relative to GDP by 2040. This means that the portion of general tax revenue devoted to funding Part B and the monthly premiums enrollees pay will have to double as well. This will be difficult to sustain without substantial changes in the tax structure.

In 2011, general tax revenue that went to fund Medicare Part B consumed 17 percent of all personal and corporate federal income taxes. If funding for Part B were to double (and if taxes remained relatively constant as percent of GDP), it would consume about 34 percent of all personal and corporate federal income taxes. It is doubtful that the government can devote such a large share of federal income taxes to just one program. Medicare will probably not remain in its current form much longer.

Some combination of increased taxes, increased Medicare premiums and co-payments for enrollees, and cuts in Medicare reimbursement rates (which may translate into effective reductions in benefits) will have to be implemented in the next several years. Everyone—those already enrolled in Medicare, those who plan to enroll in the next few years, and all taxpayers—should prepare for the coming changes.

Given that none of these actions are popular, politicians are likely to postpone them for as long as possible. But the ultimate deadline for making changes is the day the Medicare trust fund runs out. 2024 is only 12 years away.